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Option Replication in Discrete Time with Illiquidity

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  • Koichi Matsumoto

Abstract

This article studies a replication of a contingent claim in an illiquid market. We represent the liquidity as a supply curve in a discrete time model. Because the trade price of the illiquid asset is a function of the trade size in this model, it is important whether the contingent claim is physically settled or settled in cash. In both cases, we give a condition where a replication strategy exists uniquely and show some properties of the replication strategy. Further we analyse the liquidity cost numerically.

Suggested Citation

  • Koichi Matsumoto, 2013. "Option Replication in Discrete Time with Illiquidity," Applied Mathematical Finance, Taylor & Francis Journals, vol. 20(2), pages 167-190, April.
    • Handle: RePEc:taf:apmtfi:v:20:y:2013:i:2:p:167-190
    DOI: 10.1080/1350486X.2012.675161
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    Cited by:

    1. Spyridon D. Mourtas & Chrysostomos Kasimis, 2022. "Exploiting Mean-Variance Portfolio Optimization Problems through Zeroing Neural Networks," Mathematics, MDPI, vol. 10(17), pages 1-20, August.
    2. Vasilios N. Katsikis & Spyridon D. Mourtas, 2020. "ORPIT: A Matlab Toolbox for Option Replication and Portfolio Insurance in Incomplete Markets," Computational Economics, Springer;Society for Computational Economics, vol. 56(4), pages 711-721, December.

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